A Big New Worry for Corporate Directors

By JONATHAN D. GLATER

Published: January 6, 2005

The downside for corporate directors probably became deeper yesterday.

When 10 former directors at WorldCom agreed to contribute $18 million of their own money to settle a securities class-action lawsuit against them, they might have set a precedent that could affect former directors at other companies now embroiled in litigation. Members of corporate boards have every reason to hope the WorldCom settlement remains a rarity.

The directors agreed to the payment as part of a $54 million settlement, with the remaining $36 million to be paid by insurers. The $18 million is about 20 percent of the aggregate wealth of the 10 directors, not counting their primary residences and their retirement accounts.

''It's just extraordinarily rare for a director to pay money out of his own pocket,'' said Michael Klausner, a law professor at Stanford University who is studying the personal liability of directors. Mr. Klaus-ner and his fellow researchers have so far found only four cases from 1968 to 2003 in which directors contributed their own money to settle a shareholder lawsuit. ''It is extremely unusual,'' he said.

If the settlement deters people from serving on corporate boards, that will run counter to the interests of institutional investors, who have called for a greater role for independent directors in corporate governance, Mr. Klausner said. Newer laws, like the Sarbanes-Oxley Act of 2002, adopted in the wake of the Enron and WorldCom bankruptcies, are also requiring a greater role for outside directors.

This concern clearly did not deter lawyers for the lead plaintiff in the WorldCom case, the New York State Common Retirement Fund, which was determined to make the directors bear some of the pain of the settlement personally.

The WorldCom case may, however, be so unusual and the board's overlooking of facts so egregious that most directors need not worry that their personal wealth may be vulnerable to lawsuits. The WorldCom directors may have settled out of concern that details about missed wrongdoing at the company, which could have been disclosed in the course of legal proceedings, would have made them liable for a lot more than $18 million, said Robert E. Curry Jr., a lawyer at Kirby, McInerney & Squire in New York, which is not involved in the case.

''That's a lot of smoke,'' Mr. Curry said, referring to the settlement amount. ''There may be some real fire there.''

The directors could have chosen to fight the lawsuit if they thought they could win, he added. ''It's not a sure thing that directors would have to dip into their own pockets, and they certainly don't have to dip into their own pockets for their defense costs.''

The settlement may reflect a recent legal trend, Mr. Curry said. A Delaware Chancery Court decision in May held one outside director of a telecommunications company, Emerging Communications, liable because he knew or should have known that the price paid to minority shareholders in a specific transaction was too low.

''I see this as a logical extension of the Emerging Communications case,'' Mr. Curry said.

Another factor may have been the directors' insurers, who would probably have had to pay millions or tens of millions of dollars to defend them and who might have encouraged the settlement, said Howard B. Sirota, whose firm, Sirota & Sirota, concentrates on securities litigation.

''There have been many instances where, because the insured acted fraudulently, the carrier says, 'I'll defend, but when you lose, you get zero.' That's why, in this situation, they compromise,'' he said.

It is difficult to predict whether the settlement will deter potential directors from serving on corporate boards.

For the last few years, the conventional wisdom has been that it is generally more difficult to find qualified people willing to serve on boards, but that is not accurate, said Roger W. Raber, president and chief executive of the National Association of Corporate Directors, which has boards and individual directors as members.

''I don't really see many repercussions in that area,'' Mr. Raber said. In the wake of corporate scandals over the last few years, he continued, potential directors are much more cautious about joining boards of companies in trouble, but they are not entirely avoiding serving on boards.

''Directors are doing more due diligence before they accept'' such jobs, he said.

In lawsuits after the savings and loan crisis of the 1980's, some directors made payments personally, he said. However, those were most likely not cases brought under federal securities laws.

WorldCom was a one-of-a-kind case, Mr. Sirota said, and it should not signify much to directors elsewhere.

''If you were considering joining the board of a solvent company that was indemnifying you and had insurance and you weren't planning on committing fraud, then why would you be deterred?'' he asked.

Photo: Alan G. Hevesi oversees the New York State pension fund that was the lead plaintiff against WorldCom directors. (Photo by Mary Altaffer/Associated Press)